In this episode, I want to talk about what happens when the value of your assets changes during the course of your divorce process.
If you think about how long a divorce process can take, it makes sense that there would be some change in the value of your assets during the course of the divorce, unless you have all of your assets in a no-interest checking account, which is unlikely. And so the value can do one of two things, or I guess one of three.
It can stay the same, which, unless we’re talking about checking account, it really does, or it can increase or it can decrease. And the question becomes how to deal with those changes in value that occur during the divorce process.
Once you have initiated your marital separation, and you’ve made the decision to end your relationship and you’re in the negotiation process, but the values of the assets that you are discussing dividing between you keep fluctuating and keep changing, how do you handle that in your ultimate settlement agreement? Specifically, how do you handle the change, whether it be the increase or the appreciation or the decrease or the depreciation, in the assets that you’re talking about dividing?
The first thing I want to say about that is that people take, to really generalize, two different approaches to the status of their economic partnership during the divorce process.
They can either say, “Look. We’re going through the divorce process, but until we sign our final agreement, we still consider ourselves an economic unit, one economic unit. And our income is still joint, and it’s still going into the same place and we’re paying for all our bills out of our joint account or with our two incomes. If assets increase, like my 401(k) increases because I contributed to it, I’m just considering that part of the pot that we’re going to be dividing.” Basically, the approach is you still feel that you’re an economic partnership during the divorce process.
Now, many people understandably take issue with that because they feel like, “But we’re in a different era now. We’re not married and committed to staying married. We’re married but we’re committed to ending our marriage, so why would we still be in economic partnership?” And I would say that for the people who choose to go that way, a couple of things are true.
Number one, they often don’t anticipate a massive change in their assets during the divorce process. I think if they anticipated a massive change in their assets during the divorce process that it might be more important to them to say, “Mm, well, no. Let’s draw a line in the sand here because any gains that I have going forward that are substantial, I don’t really want to be sharing.” That’s one common factor of people who say, “Well, yeah, we’re still an economic partnership.”
But the other reality is that if you decide that you’re not an economic partnership, you then have to pretty immediately figure out what the support between you is going to be. And that’s a tough process. It’s a tough decision. It’s hard to get to that number. It’s one of the more challenging components of the divorce process. And many people, at the outset of the process and in the middle, still don’t know what they want to do about that. That’s part of what they’re working through.
And so it sort of feels like even if it doesn’t feel intuitive to them that they are an economic unit, it still feels premature to say that they’re not because they’re not ready to say what their support transfers between them are going to be.
So, people can say, “We’re an economic unit until we sign our final contract.” And if that’s the case, then the approach tends to be: “Whatever changes happen to our assets, whether they increase or they decrease, we’re both in on that. We’re going to handle that just as we would have handled it during the marriage, which is to say, we share it.”
The other approach that couples take when they’re going through a divorce process is to say, “As of the day we physically separated, or as of the day one of us filed in court, we’re no longer an economic partnership. We’re not in it together for increases in assets or decreases in assets. We’re now separate economic actors, and we need to figure out how to handle any increases or decreases in our marital assets during this divorce process because we don’t intend to share them.”
Let me talk a little bit more about that situation because that’s where it can get a little complicated.
If you do not see yourselves as acting as an economic unit during the divorce process, and the value of your assets change during the process, and I’ll talk first about if the value of your assets goes up, the distinction you want to look at initially is why, how did your assets appreciate in value?
Let’s look at a 401(k), for instance. A 401(k) can appreciate in value basically two ways: (1) You are contributing money to it. That increases the balance in your 401(k); and/or (2) the market is growing. Whatever your 401(k) is invested in is growing in value. And even if you did not contribute another penny to you 401(k), if the market is growing in value, your 401(k) is growing in value.
So, just to take that retirement asset, it can grow because you’re contributing to it during the divorce process and/or it can grow because the market is just growing during the divorce process.
Where the growth in your retirement asset or any other asset is as a result of growth in the market and really nothing that you’re doing, you haven’t contributed, you haven’t made any efforts to increase the value of your asset during the divorce process, it’s just growing with the market, in general, that increase in value in an asset is shared even if you no longer see yourselves as an economic partnership. It’s not a hard and fast rule, just a general rule of thumb.
Whereas, let’s say the market has been completely stagnant, it’s not grown, but you’ve been contributing $1500 every month to your 401(k) and the balance is increasing by $1500 every month during the divorce process, well, if you don’t see yourselves as an economic unit during the divorce process, then the increase in value in your asset that’s due to your efforts, your contributions, things you’ve done, is going to be something, generally speaking, that you want to retain and not share with your spouse.
Again, this is not a hard and fast rule. It’s just a general rule of thumb for people who do not consider themselves to be an economic unit during the divorce. When they think about how to share or not share the changes in the value of their assets during the divorce, one key point they’re going to look at is “Okay, my asset has appreciated in value, but why? How? Is it because of something I’ve done? Have I contributed to it with financial contributions or contributions of my time and effort and expertise? Is that why this has increased in value? Or, is it rather nothing that I’ve done, but because whatever I’ve invested it in has grown without my efforts contributing to that?”
In reality, oftentimes, the growth is due to a combination of both of those things. You’ve contributed to it, but also the market has grown, and so there can be a little bit of untangling to do at the time of figuring out, “Okay, what of this growth in this asset value during the divorce process are we going to share, and what of it is just to be enjoyed by one person because it was really due to that person’s efforts during the divorce process?”
Another area where this comes up quite a lot, especially in New York City with the real estate market, is that a real estate asset, a home, an apartment often increases in value during the course of the divorce process, especially if your divorce process is spanning a couple of years.
Same rule of thumb generally applies. If your home has appreciated in value because you did some kind of major renovation to it that you paid for on your own, and again, you are not considering yourselves an economic unit during the divorce process, well, then you would likely reap the benefits of that increase in value in the home due to whatever you did to make it increase in value.
More often than not, the increase in value in the home or the apartment during the divorce process is just due to market forces. Not a lot of people undertake a renovation of their home while they are getting divorced. Very few people do that.
If the market has gone up and the value of your home has gone up, most common practice is to take the value of the home as it is at the time you’re dividing your assets, so closer to the end of your divorce process rather than to say, “Well, we separated in 2015, and the home was valued at $1 million at that time, and now it’s up to $1.4 million three years later. But I’ve been living in the home and so that’s my gain to keep.”
Well, not necessarily. If there’s really nothing that you’ve done to make the home increase, and it’s just an asset that’s appreciated with the market, oftentimes, that appreciation is shared between the spouses, even if only one spouse is living in the home.
Sometimes a different approach is taken if one spouse is not only living in the home, but they alone are paying all the costs of the home and paying down the mortgage. Sometimes they’ll negotiate that they have essentially taken over the asset as of whatever date they started paying for it and living in it and that any increases in the value of the asset would be theirs to enjoy.
I would say that’s more common in terms of if a spouse is living in the home and they’re paying down the mortgage and the principal balance is reduced as a result of one spouse’s payments. Often, that spouse will get the benefit of the pay down of the mortgage for the time that they have been living in there alone because that’s seen as an increase in the home equity due to that one spouse’s efforts as opposed to an increase in the equity of the home due to an increase in the fair market value of the home, which is just tracking the real estate market in the particular area that you live in.
Another question that I find useful to ask couples who are trying to figure out if they should both have a stake in, and this comes up when assets both appreciate and depreciate. And let’s say an asset has really grown in value.
Let’s say one of the spouses has equity in a startup that he or she is working at, and over the course of the divorce process, the startup has just skyrocketed in value and that equity is worth a ton more than it was at the time that the spouse has agreed to conclude their economic partnership when they started the divorce process or during the divorce process. You can ask yourselves the question of, “Okay. At the outset of this process, when we decided to become separate financial actors and end our economic partnership, if we had had to make a decision at that time about whether or not both spouses would be in for any changes in this asset,” obviously, if you want to be in for the upside, you have to be in for the downside. Nobody would negotiate a deal where they guaranteed, or very few people at least would negotiate a deal where they guaranteed, their spouse 50% of any increase in the value of an asset but insured their spouse against sharing 50% in any decrease of an asset. That wouldn’t make sense.
It can be useful to think about, “Okay. Wait a minute. If we negotiated this at the time that we agreed to end our economic partnership and we said okay, are we both in for any upside and any downside? If so, great. Then we’ll share it as we go.” Or does one spouse feel like “I don’t really want to be in for the downside. I’d rather just know what I’m entitled to with this asset. And then if there’s any upside, you can have it. But if there’s any downside, you can have it.”?
If that’s the case, that’s certainly another fair way to approach things. But you want to be mindful of whether that would be your approach. Because if it would have been your approach, then sharing in the appreciation of the asset just because things went well is not really a fair way to approach the division of that asset vis-à-vis the spouse who would have had to take on the downside if there were a decrease in value.
For that reason, if you, at the outset of the process… Again, this is only relevant if you feel like “We’re separate economic actors. We are not an economic unit anymore,” because if you don’t feel that way, then this is irrelevant. But if you anticipate being separate economic actors, then you want to give some critical thought to what are the assets of yours that could increase or decrease in value substantially during the divorce process?
And it serves you to address how you’re going to handle, share or not, any appreciation or depreciation in those assets during the divorce process. It serves you to address that at the outset because your answers about how you want to handle that asset and whether it goes up or down are going to be more honest at the time, at the outset, when you don’t know if the asset is going to go up or down. They’ll be more realistically true to whether or not each spouse wants to shoulder the risk of depreciation but also share in the upside of appreciation.
When you try to have that conversation retrospectively, in a way, it’s kind of hard because you know whether the asset went up in value or went down in value. And so, of course, if you know that the asset went up in value, the non-titled spouse, the person who doesn’t own that asset, of course, they’re going to say, “Yes, I want to share in the upside and I would have shared in the downside,” and they will likely believe that. And the other person is often going to feel like “Nope. I don’t want to share in the upside and you wouldn’t have wanted to share in the downside.”
So you can find yourselves a little bit of a stalemate around that issue because you’re sort of trying to recreate an uncertainty in the past that doesn’t exist anymore. It is certain what ended up happening to the asset and then each person often wants to handle the appreciation or depreciation in a way that is beneficial to them. That’s natural.
So if you can have that conversation at the outset, it can really simplify things down the road to clarify, “Okay. With regard to changes in this asset, are we in it together and we’re in for the upside and in for the downside?” or does one person not want to be involved in that volatility and they’re fine just being entitled to whatever the value was as of the date you decided to end your economic partnership, and whatever happens to the asset after that, they don’t really care about?
I see that come up a fair bit with startup equity. Oftentimes, the non-titled spouse is just not interested in the volatility of that asset or investment, and so they’d rather have a guarantee of sharing a certain value that they know they’re going to receive than be in for the upside but possibly receive nothing if the value of the asset really tanks. And then, of course, for the titled spouse, the question is how likely do they think the asset is to appreciate versus depreciate, and do they want to insure their non-titled spouse against the downside of depreciation in the asset in exchange for getting to retain all of the appreciation in that asset during the divorce process if there is any?
That was our mini-episode on what happens when assets change in value during the divorce process, which they often do. I hope it was helpful for you.